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Why NeoPhotonics Corp. Plunged Today

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What happened

Shares of NeoPhotonics(NYSE: NPTN) fell as much as 29.9% in Friday's morning session, hamstrung by a disappointing third-quarter earnings report.

So what

The maker of optoelectronic components for high-speed fiber-optic networking equipment saw revenue rising 23.6% year over year and landing at $103.3 million. Gross margins thinned down from 29.8% to 27.6%, and adjusted earnings fell from $0.11 to $0.05 per diluted share.

Analysts had expected earnings near $0.14 per share, culled from roughly $104 million in top-line sales.

Looking ahead, NeoPhotonics' management now expects to deliver adjusted earnings of approximately $0.17 per diluted share in the fourth quarter, based on revenue of roughly $113 million. Both of these targets are significantly below the current analyst view, which calls for earnings of $0.23 per share and sales closer to $117 million.

Now what

The third quarter was hampered by the unexpected bankruptcy of a product distributor in China, which reduced both the top and bottom lines by $2.25 million. NeoPhotonics also triggered the vesting clause in its stock-based compensation contracts, because share prices traded above $15 per share for more than 20 consecutive days. That's another $5 million charge against operations and the cost of goods sold. Without these one-time events, sales would have stopped at $105.6 million, while adjusted earnings would have held steady at $0.11 per share.

The distributor bankruptcy held back some of NeoPhotonics' most profitable high-end products. Components designed to operate at 100 gigabits per second and beyond saw sales rising 38% year over year, and now account for two-thirds of the company's total sales. But without that Chinese event, this product category would have seen 54% annual growth.

That being said, today's extreme market backlash looks like an overreaction. The Chinese distribution path has already been corrected and management expects no further impact from that issue.

I'm tempted to dig deeper into NeoPhotonics while this sudden buy-in discount is in effect. The stock now trades at a mere 10.7 times forward earnings estimates, right on the doorstep to the next industrywide wave of network infrastructure upgrades.

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